Capital Market Expectation Flashcards
Identify the process to formulate Capital Market Expectations
Step 1 : Determine the specific capital market expectation in line with the investors allowable asset classes and investment time horizon
Step 2 ; Analyze the historical performance of the assets to understand the drivers of the performance. We can then use these to forecast expected return performance.
Step 3 : Identify the valuation model to be used
Step 4 : Collect the data (input) that will be used in the model
Step 5 : Use judgment to make sure that the inputs are consistent with the asset class being use
Step 6 : Formulate capital market expectation
Step 7 : Monitor performance and use it to refine the process.
Define Cross-Sectional Consistency ?
Build a consistency across the asset classes in your portfolio in terms of risk and return characteristics.
Define Intertemporal Consistency ?
Consistency in the invesment horizon regarding portfolio decision
Explain the concept of Uncovered interest rate parity (UIP)
Exchange rate changes should equal differences in nominal interest rates.
Define limitation to using economic data when forecasting asset classes :
- Time lag between collection and distribution is often quite long.
- Data are often revised and the revisions are not made at the same time as the publication.
- Data indexes are often rebased overtime
Explain types of measurement errors and biases that can occur when forecasting asset classes :
Transcription errors : Misreporting or incorrect recording of information.
Survivorship bias : Occurs when manager or a security return series is deleted from the historical performance record of managers or firms. Deletions are often tied to poor performance and bias the historical return upward.
Appraisal Data : Illiquid and infrequently priced assets makes the path of returns appear smoother than it actually is (often the case with real estate securities)
